Shock Me, Shock Me

At the peak of the boom in 2006, over a third of all U.S. home purchase lending was made to people who already owned at least one house. In the four states with the most pronounced housing cycles, the investor share was nearly half--45 percent. Investor shares roughly doubled between 2000 and 2006. While some of these loans went to borrowers with "just" two homes, the increase in percentage terms is largest among those owning three or more properties. In 2006, Arizona, California, Florida, and Nevada investors owning three or more properties were responsible for nearly 20 percent of originations, almost triple their share in 2000.

Pointer from Mark Thoma, who sees it as an exoneration of government housing policy. Hunh? Loans to speculators were made by Freddie and Fannie. Loans to speculators were eligible to be laundered into AAA securities that were favored by government capital requirements. The sad fact is that the real estate lobby was so good at playing the violins for "home ownership" that they were able to put a smokescreen over a wave of speculative borrowing.

But to me, the most point to be made about the role of speculators is that "foreclosure prevention" is misguided policy. Here is what I wrote in October of 2008:

Anyone who wants to stop mortgage foreclosures needs to have his head examined. How many of the bad loans are investor loans, where the borrower never occupied the house? 20 percent of them? 50 percent? 70 percent? We know that in the last years of the bubble more than 15 percent of mortgages were for non-owner-occupied (the true figure might actually be higher than reported, because it is common to fraudulently claim that you will be using the home as a residence when you will not). Investor loans default at a much higher rate than regular loans, somewhere between 3 and 10 times as much. If it's 4 times as much, then already we can be surmise that a majority of bad loans are investor loans. The best thing to do with those is to foreclose ASAP.

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Loans to speculators were eligible to be laundered into AAA securities that were favored by government capital requirements. The sad fact is that the real estate lobby was so good at playing the violins for "home ownership" that they were able to put a smokescreen over a wave of speculative borrowing.

There's probably something of a negative feedback loop in effect here. As speculators bid up the pricing of housing, it becomes less affordable, which can be used to justify easier lending standards. As the average price of a home goes higher, fewer and fewer people are able to come up with a 20% down payment, necessitating (for the good of the working class!) that it be reduced to 15%, which enables more speculation, then 10, then 5, then aw, what the heck? You got $200 to cover the loan application fee?

Well, actually, the information does not go against the claims that the loans went to unqualified borrowers in poor areas. We do not know where it went. One famous anecdote is about a hedge fund manager who found that his maid owned five homes--and that's when he decided to look for securities he could short.

The more mysterious question is how do these things start, and why was California (plus Vegas and Phoenix) such a huge part? At one point California alone accounted for about 70% of the problem loans.

I have yet to see any analysis by the educated academic commentariat on this question. Bubble prices tracked in NJ and NY at the same time, but not the financing. In addition to the speculators and the unqualified non-speculators were the biggest category of all---the refinancers. Most of the money financed was refinancing with cash being taken out at larger assessed prices----again dominated by California and its two moons. The RMBS securities and their derivatives (CDOs) were also dominated by CA etc.; with Fla. a distant second.

Unless we believe in spontaneous financial combustion (why not?---Physics "Big Bang" is effectively uncaused spontaneous "Inflation"), there is a discoverable cause. All discussions on the bubble are "Macro" in nature with no Hayekian local knowledge analysis. Maybe I have missed this discussion, but I cannot find it.

My repeated refrain, is we took a relatively severe local real estate bubble, and through genuinely idiotic and corrupt policies turned it into a global crisis.

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